To Be a Great Investor, Worry More About Being Wrong Than Right

If all you learn from the stunning surprises of 2016 is that the unexpected will happen, you haven’t learned nearly enough.

Great investors like Warren Buffett practice trying to disprove their investing assumptions to determine whether they are correct. This past year showed how tightly most of us cling to our preconceived notions, how fiercely we resist evidence that we might be wrong and how adept we are at deluding ourselves into thinking we were right all along.

If you were a Hillary Clinton supporter, every statement by Donald Trump fortified your faith that he would lose the election, and you took the consensus of polls as proof she would win. Mr. Trump gave supporters reason to think he’d ​chasten Wall Street, and as the election approached, pundits predicted a market meltdown if Mr. Trump won. Yet the S&P 500 has returned more than 5% since his election.

Ever since Nov. 8, voters have been scrambling from all sides to avoid admitting that we were wrong. If that requires fibbing to ourselves, so be it.

Likewise, instead of opening their minds to the possibility of being wrong, investors often wall themselves off from new information that could threaten their views.

In the summer, with the world awash in negative interest rates, The Wall Street Journal reported that this “new abnormal” was “here to stay” and (as yours truly wrote) that “you will have to lower your expectations” for bond income. Right on cue, the yield on the 10-year U.S. Treasury — then 1.37% — has nearly doubled in less than five months. While yields remain near historic lows, they are widely expected to go up next year as the Federal Reserve continues raising rates to keep the economy from overheating.

As Keith Stanovich, Richard West and Maggie Toplak point out in their new book, The Rationality Quotient, rational beliefs “must correspond to the way the world is,” not to the way you think the world ought to be. If you can’t be honest with yourself about the difference between the truth and what you think ought to be true, you may well be intelligent, but you aren’t rational.

In a recent survey sponsored by the Finra Investor Education Foundation, 2,000 investors were asked what the S&P 500 would return over the next 10 years. Those who estimated that stocks would earn an average of at least 20% annually for the next decade scored higher on a test of financial literacy than did those who estimated it would gain between 15% and 20%.

That 20% estimate isn’t impossible, but it is highly improbable. Since 1926, the S&P 500 has returned an average of 10.1% annually, says Howard Silverblatt, a senior analyst at S&P Dow Jones Indices, and the closest it came to 20% in any decade was in the 1950s, when it averaged 19.2% annually.

A few techniques can help combat these cognitive biases.

Shun peer pressure from social media or the Internet. If you reveal your opinion to a group that has strong views, the sociologist Robert K. Merton has warned, the ensuing debate becomes more “a battle for status” than “a search for truth.” Instead, get a second opinion from one or two people you know and can trust to tell you if they think you are wrong.

Listen for signals you might be off-base. Use Facebook or Twitter not as an amen corner of people who agree with you, but to find alternative viewpoints that could alert you when your strategies are going astray.

T​ake a few moments t​his weekend​ to write down your estimates of where the Dow Jones Industrial Average, oil, gold, inflation, interest rates and other key financial indicators will be at the end of 2017. If you don’t know, admit it. Ask your financial advisers to do the same. Next Dec. 31, none of you will be able to say “I knew that would happen” unless that’s what the record shows.

To be a good investor, you have to be right much of the time. To be a great investor, you have to recognize how often you may be wrong.